DealBook | With the Volcker Rule, the More Regulators the Merrier
Legal/Regulatory | Another View
With the Volcker Rule, the More Regulators the Merrier
By David Zaring
December 9, 2013 5:54 pm December 9, 2013 5:54 pm
David Zaring is assistant professor of legal studies at the Wharton School of Business at the University of Pennsylvania.
The Volcker Rule is the latest version of a phenomenon unique to American financial regulation. Issued by five agencies, more or less at the same time, it is one rule with many masters.
In other countries most financial regulation is done by one, or perhaps, two, agencies. Yet there are some positive outcomes with the American approach of having so many different regulators doing the same thing.
Certainly, this hodge-podge of agencies suggests that problems will occur. At its best, it can create a market for laws, with investors and financial institutions flocking to the agency that provides the most sensible regulations. On the flip side, this duplication in the system results in fail-safes and fallbacks: when one agency fails to do its job, another can step in in its place.
None of this means that the creation of our architecture of financial regulation was done with much forethought. Of the five agencies behind the Volcker Rule, the three bank regulators — the Office of the Comptroller of the Currency, the Federal Reserve and the Federal Deposit Insurance Corporation — were each created at different times for different purposes. The Office of the Comptroller of the Currency was a product of the Civil War. It was created to charter national banks, which could hold dollars issued by the federal government, and thereby help the government manage its war debts.
The Federal Reserve was meant to be a central bank. It was created in 1913, and was eventually given powers to regulate bank holding companies or corporate structures that owned banks.
The Federal Deposit Insurance Corporation was created in the Great Depression to provide assurance to retail customers that their bank deposits would be safe; because insurance companies do not like to insure risky ventures, they were given some supervisory powers over almost all banks – powers that increase as banks get into more trouble.
The trading components of the Volcker Rule are meant to be overseen by both the Commodity Futures and Trading Commission and the Securities and Exchange Commission. Industry analysts and economists have long scratched their heads over the need to have two capital markets regulators overseeing debt and equity securities in one place and futures and derivatives securities on the other, particularly considering that many futures and derivatives traded today reference debt and equity securities. The S.E.C. and C.F.T.C. are supervised by different congressional committees – finance services and agriculture. Both senators and representatives are likely to be loath to give up their oversight of agencies that regulate financial firms, which are a generous source of campaign donations.
No other country has created such a patchwork of agencies to deal with financial oversight. Henry Paulson, a former Treasury secretary, called for a rationalization of financial regulation before the financial crisis in 2008. You wouldn't dream up a world where a rule on proprietary trading by banks has to be administered by five agencies, if it is going to work at all.
Nonetheless, even historical accidents have their merits. Cass Sunstein, the former White House regulatory czar, has long argued that group dynamics — whether they involve multiple judges looking at the same issue, or multiple agencies thinking about the same regulation — can moderate the extremes, and, perhaps, reflect the more careful deliberation that a give-and-take among decision makers should produce.
Moreover, if those regulators, in the end, decide to do things differently, we might expect the benefits of experiment, followed by market discipline, as investors flock to those financial institutions subject to the regulations most likely to keep them profitable and solvent. This "market for law" is one of the reasons we tolerate a world in which any company can incorporate in any state. Such a structure permits the company to choose its own rules, and encourages states to either copy the best rules, or to try out innovations in the hope of obtaining more corporate charters.
The existence of an efficient market for law, to be sure, is a subject of heated debate in academic circles. If companies can choose their own regulators, won't they pick the softest touch, rather than the best one? It seems plausible, but when Dain Donelson of the University of Texas and I looked at how banks subject to different regulators – some of whom occasionally changed supervisors – performed during the financial crisis, we found no evidence of outperformance, regardless of the regulator chosen. In other words, perhaps regulatory competition leads to a level playing field of supervision rather than lax enforcement.
The final upside of the multiple regulator model might lie in its redundancy. If some regulators are asleep at the switch, other regulators remain vigilant. The New York Times Op-Ed columnist Joe Nocera speculated that the implementation of the Dodd-Frank Act has benefited from the aggressiveness of the C.F.T.C., which has been timely with its rule-making, stern in its enforcement, and quite successful in its litigation. With one agency working so hard, it might not be so bad that another agency – the S.E.C. – has fallen so behind on its rule-making.
These are all plausible advantages, and reasons why I do not despair over our patchwork regulatory system. But while they sound promising when considered individually, it is less clear which predominate when examined together.
Do multiple regulators create value through consensus, or competition? Do they promote efficiency through specialization, or valuable inefficiency through redundancy? These are questions that are difficult to untangle. But if we really wanted to be able to predict how the implementation of multi-agency rules like the Volcker Rule will work, we would do well to figure them out.
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